Rich Girl Roundtable: Business Writeoffs & Tax Hacks for the Fully & Partially Self-Employed

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What can you write off from your side hustle? Should your business be an S Corp? What’s the best retirement account for self-employed folks? We cover it all, once again with the help of CPA & CFP Tim Steffen of Baird Wealth.

Reminder: This is not financial advice; please do your own due diligence with a licensed professional.

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Our show is a production of Morning Brew and is produced by Henah Velez and Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is President of Morning Brew content and additional fact checking comes from Scott Wilson.

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Mentioned in the Episode

• S Corp vs. LLC

• K-1 form for S Corps

• S Corps, per the IRS

• Business use of a car, per the IRS

• SEP IRA vs. Solo 401(k) for business owners

• The most optimal accounts for W-2 and self-employment earners

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Katie:

Welcome back Rich People to the Rich Girl Roundtable, weekly discussion of The Money with Katie Show. I’m your host, Katie Gatti Tassin, and every Monday we discuss a relevant money topic a little more casually than we do in our Wednesday deep dives. And in keeping with some of our Q1 theme here that you might’ve picked up on. Again, we are talking about taxes. Before we do that, here’s a quick message from our sponsors. Alright, everyone, circle around the table. Henah, how are we doing today? What is the question?

Henah:

I’m good. I’m going to welcome back Tim to the show, the man, the myth, the legend. He is here to regale us the third time with his tax tips. So this week’s question is about tax write-offs for people who own businesses or otherwise have self-employment income. So what can or can’t you write off with a business as a tax deduction? How do you look for them appropriately and track them? What are some lesser known write-offs, et cetera? So I will preface, which we alluded to last week, that we got a lot of questions that we would categorize broadly as is this tax fraud. So Nick, we’re going to need you to do a little base drop, need a jingle…

Katie:

Is it tax fraud? Maybe you can use that. Add some base.

Henah:

This tax fraud. Is it tax fraud?

Katie:

Add like a little clarinet?

Henah:

We’re going to try and find some clarity today from Tim. So Tim, thanks so much for being here.

Tim:

Great to see you both again.

Henah:

Yes, long time no talk.

Katie:

Can I start us off with what feels like the question we get the most?

Henah:

Absolutely.

Katie:

So we got and always get so many questions about whether or not someone should become an S Corp, and I think that’s because this is one of these topics that’s very hot on social media and on TikTok. Can you lay out the broad facts for us? I think in one way I think there is a little bit of a misunderstanding about how S Corps relates to other things like LLCs almost in the same analogy field of every square is a rectangle, but not every rectangle is a square thing. I think there’s a little bit of confusion there as well as how they actually work and why people use them. So maybe let’s start there.

Tim:

Sure. So starting on just the structure of your business, the common question, should I be an LLC or an S Corp? And to your point Katie, the answer is you can be both. Because an LLC is a legal structure. An S Corp is a tax structure and you can be both. That doesn’t mean you should be, but you can be. So you start a business if you don’t do anything, if you don’t do any legal documents, any filings, anything like that, you are default by default a sole proprietor. As soon as you get together with another person and the two of you own a business, now you need to get more formal and legalize it. And two people together have a couple of options. You can become a partnership, you can become an S Corporation, you can be a C corporation. Overarching all of that is the LLC.

The LLC is a legal liability company structure that provides the owners a little different level of liability protection. If you form an LLC, which frankly most business owners, it can probably pay to do that, especially if you’re a sole proprietor. If you’re an LLC and you’re what they call a single member, you’re the only one in that business. You are by default the sole proprietor, and that can work fine for the vast majority of people if you bring another person into that LLC. Now you are by default a partnership for tax purposes. You can choose to become a corporation, in which case you could become a C corporation or an S Corporation. We’ll ignore C Corporations right now that’s like your publicly traded companies. We’re not really worried about those too much. You don’t see that often with these small businesses. Partnership versus S Corp, very similar in a lot of ways from a tax reporting standpoint.

They have some unique rules and limitations on and pros and cons to each of them. But if you’re a single individual and you’ve got your own business and you want to put a structure around it, LLC is probably the way to go and remain as a sole proprietor. You don’t have to file any separate tax return like an S Corp or a partnership does. You can keep it all on your own personal 1040. It’s just a lot easier to manage. As soon as you start getting into some bigger entities, you’ve got co-owners, then you’ve got to look at other types of structures. But for most people who are on their own, an LLC filing is a sole proprietor is going to be perfectly fine.

Katie:

Okay, interesting. So with that S Corp, help me understand a little bit better why it is such a buzzword or why there is so much emphasis on them as a means that’s going to save you a bunch of tax money. And if you make the classic kind of phrase that I always hear is if you make more than $60,000 a year in your business, you should be an S Corp. I have no idea why that is the threshold above which people describe that tax status as advantageous. Do you have any insight there?

Tim:

So yeah, there is one very important structural difference on an S Corp versus a sole proprietor. So again, we’ll assume you’re the only owner of this. Take partnership out of the equation. So it’s a sole proprietor or an S Corp, whether you’ve got an LLC wrapper over them both or not, doesn’t really matter for the purposes of this. So if you’re a sole proprietor, you pay tax on all of the income of the business. You also, because you’re self-employed, have to pay employment tax on all of that. So I’m an employee, I pay FICA and Medicare on my salary. My employer pays that same tax on my behalf if I’m self-employed is both of you might have self-employment income. You pay both those halves. You pay both the employer and the employee half on all of your net self-employment income. If you go to an S Corporation, S Corporation is taxed a little differently.

An S Corporation is a separate legal entity. It files its own tax return and it issues you as the owner. What’s called a K-1? A K-1 is just a statement that says here’s your share of the income from this particular business. Income that’s reported on a K-1 is not considered earned income. It’s not considered wages. Therefore that income is not subject to employment taxes, FICA and Medicare and those kinds of things. So because of that exclusion from employment taxes, a lot of people think, I’m going to take my self-employment income, throw it into an S Corp, have all my income come to me on a K-1 and I can avoid all the employment taxes. And in theory, that works perfectly well. As you might suspect, the IRS is onto this. They’ve said that if you work for an S Corp, if you’re an owner of an S Corp and you provide services to that S Corp, you have to pay yourself a salary.

So now I’m an S Corp that generated a hundred thousand of income. I have to then pay myself some of that as a salary. I can’t pay myself a dollar. I have to pay myself a reasonable salary. What would it cost to hire somebody to do what I do? How would the income change if I wasn’t involved in the business? That amount has to be paid in a W-2 to me, it reduces the amount that’s on the K-1 because it’s deductible. So the total income is the same. It’s just that now you’ve shifted some of that S Corp income to a W-2, which subject to those same employment taxes we talked about before. This is one of the things you’ve got to be careful about taking advice from people who have not really dug into this. But yeah, if you put your income into an S Corp and you pay it on a K-1, you’re going to avoid employment taxes. You’re also going to be running a file of tax law that says you have to pay yourself a salary, which is subject to those same employment taxes.

Henah:

Time for the jingle.

Tim:

So yes, S Corp could be wonderful planning tools and wonder from a liability standpoint and grid from a structure, but they are not wiping out a tax liability necessarily.

Katie:

Can I ask a clarifying question there too? I think back in the day when Terry and I were going back and forth on this, he was like, well, you’re making, I believe at the time our household income, we were already married filing jointly. We were already maxing out, we’ll say on our social security obligation. So we had already fulfilled, and I can’t remember exactly what the, at least on my side of the income equation, I as a human did not owe any more social security tax. And so he’s like, that’s the bigger portion of this self-employment tax. You’re mostly covering it. You’re really not going to save that much. We’re talking 3% in Medicare taxes to go jump through all these hoops to do this. And so we opted not to do this, but one thing that I was always unclear about, but for me that side hustle turned full-time job, the money that I was making from it, I wanted to invest that money.

I wanted to put it in a Solo 401(k), I wanted to put it in a taxable account. I wanted to put it to work for me. I didn’t want to just sit in a business checking account somewhere getting 0.1% in yield and it was never clear to me. If you go through this process of becoming an S Corp or putting that tax wrapper around your organization, does that not mean that you cannot personally now go and invest that business income? That seems like a pretty big what is actually happening to that business income tactically? Practically behind the scenes does it mean it literally just has to sit in a business checking account in the business’s name?

Tim:

So if you are an S Corp shareholders, what they’re called, you are an owner in an S Corp, your shareholder, you pay tax on your share of the business income. So if you’re the only shareholder, any net income in the business you fully pay tax on whether you see those dollars or not, you might keep all that money invested in the S Corp to reinvest back in the business. You still have to pay tax on it on that net income. So what many business owners will do is they’ll distribute that income out to the shareholder or at least enough to cover the tax liability, but you’ve already paid tax on, if you take that money out of the business, it’s yours. You don’t pay a second tax by taking it out, which means there’s no penalty necessarily for taking it. So yes, you could take that money out, it’s yours. You can invest it however you want. You could also invest it in the business itself. There’s some rules that kind of limit how you could do that, but generally, yes, the S-Corp could invest that in the market if they wanted to as well. But if you’re an S-Corp shareholder, you might as well take that money out and invest it yourself. Or if you want to keep it and grow the business, you can do that too.

Katie:

Interesting.

Tim:

To your point about the retirement account or savings, if you leave that money in the S Corp and it just go back to our K-1 versus W-2 discussion, if that income just stays on a K-1 and you don’t report it as W-2 income, you one aren’t paying, yeah, you’re not paying the FICA and Medicare tax on it. You’re also not accruing a social security benefit for when you retire, whether that’s valuable to you or not. You also can’t shelter it in a retirement plan because to put money into a retirement plan, you have to have earned income. If it’s not on a W-2, you don’t have earned income or if it’s on a K-1, it’s not going to be, in most cases, qualify for a retirement plan. So yeah, you may save a little bit to tax dollars upfront by keeping it on a K-1, but you’re missing out on perhaps other opportunities that could be even more valuable.

Katie:

Maybe that’s the calculation someone would have to run, but just from where I was sitting, I was like, well, I think I’d rather take all of it as income, contribute 20% of it to this Solo 401(k) and not pay unquote nothing on that portion than to save the 15%. I don’t know. I mean there’s a lot of, that’s why you work with the CPA, right? Is to make sense of that and run the numbers and determine what makes sense. But thank you for clarifying. That was always something that I was like, so wait, if you’re only taking that lip, does that mean you can’t invest this money? That seems kind of shortsighted. You’re saving 15%, but then you’re not going to be able to invest the money and make more money with it, which seems kind of shortsighted.

Henah:

And this is this tax fraud with Katie Gatti Tassin. So moving on to common business deductions. So we’re going to make a list. So the big ones that we always hear about are the square footage of your home for the part of your home that’s a home office, cell phone, bills, wifi. What else is there? What are some of the lesser known things that we should look out for? I know Katie has a very specific example too. So

Tim:

The overriding theme when it comes to business expenses is two words, ordinary and necessary are these expenses that are ordinarily incurred in the type of business that you run. So for example, if I run a lawn mowing business, I can’t go out and buy a horse and treat that as a deductible expense because most lawn mowing businesses don’t need to own a horse. And is it necessary? Is it something that I need to incur to run my business? So again, I’ve got a lawn mowing business buying new trimmers and gas and lawnmowers. Those are necessary expenses for the business. Going out and buying a new sports car, probably not necessary.

Henah:

Do you own a lawn mowing business? You seem to have these deductions very clearly right off the top of your head.

Tim:

I’ve had a few clients in the past.

Henah:

Oh, well good to know. Lucrative business perhaps that makes total sense to me. So I think for that case, a home office, cell phone, wifi. I know for me personally, when I had a website for people finding my portfolio and reaching out, I put the email provider that I had to pay $5 a month to or whatever. Those as well. Katie, you have a very specific one. Do you want to throw it out there? I see you’re laughing.

Katie:

Okay, so no, this year, it’s funny that you mentioned sports cars because this year I purchased a Porsche and I was of the mind that maybe I can shoehorn this car into enough content and drive it to enough meetings and to the airport enough times. See when I travel from work that I will be able to write off the value of this car even though drop is a tax drop probably, and it does not weigh more than 6,000 pounds. So I don’t think that it qualifies for that, whatever it used to be for lake trucks and tractors, and now people use it for heavy Range Rovers and G Wagons IRS. They’re just taking Ls all over the place. But yes, tell me why that’s not allowed.

Tim:

I won’t tell you it’s not allowed entirely. What I will say is that with any kind of asset like that where you use it for the business, but I suspect you’ve probably driven the Porsche to the grocery store or to dinner maybe once in a while with your husband, something like that, you have to allocate the use of those assets between business and personal.

Katie:

So what I’m hearing is I have an in…

Tim:

To the extent you’re using it for business purposes, driving to meetings, driving to the airport with vehicles in particular, you typically deduct based off your mileage, there’s what they call a standard mileage rate. Every mile you drive, you can deduct a certain amount. That number’s actually gone up quite a bit because of inflation. Everything’s gone up. So that number’s gotten a little bit bigger recently, but with a vehicle in particular, the best thing to do is keep a log of all the miles you drive, and then at the end of the year, here were my business miles, here were my personal miles, all those business miles, you get a x cents per mile write off that you can claim as an offset to your business income. Now again, you’re going to want to document that the IRS wants contemporaneous written documentation of these things. So you have to keep a log.

They don’t want you recreating it at the end of the year. You got to keep a log. That’s really important. But then if you do that, you can write off an expense per mile. You could also go back and say, well, I’m going to add up all the gas I spent and the cost of my insurance and all the maintenance and upkeep I did to my car. Add up all those expenses throughout the course of the year and then allocate a portion of those based on my business versus personal miles. That’s a lot of work, a lot of record keeping, a lot to do. It’s much easier to just use what they call the standard mileage rate.

Katie:

Gotcha. But it does not sound like, what I’m not hearing is that there’s any sort of, oh, Katie wants to drive a Ferrari to the business meeting. So she’s going to deduct the full value of that Ferrari this year because she spent a hundred percent of her time in it driving to meetings. They’re not going to float to the, oh, it was a hundred thousand dollars. Okay, cool. Well yeah, just wipe it off the top.

Tim:

Then again, if the car was used exclusively for business, you could say all the expenses of the car were business use. So for example, go back to the lawn mowing example. They’re buying pickup trucks that are used exclusively for the business, all the expenses associated that would be with the business. But for your Ferrari example, I go back to the ordinary and necessary, you could argue that maybe you don’t need a Ferrari, that that might be a little extravagant for the nature of the business. You could say, well, I’ve got an image to uphold. I’ve got a brand to promote. The Ferrari helps with that. Those are all arguments that people make with varying degrees of success.

Henah:

Okay, so there are a couple emails we got where someone said, there’s a bunch of content on TikTok about how to write off as many things as you can or that you pay your kids as employees. A lot of things using TikTok and social media as its source material. And we got one particular question that we thought was very funny. It said, I have friends who barely make a profit in their businesses, but they think that charging stuff on their business credit card will lower their tax liability. Tell us maybe that why that’s not maybe the case, why that’s wrong.

Tim:

Cue that sound drop again here, guys.

Henah:

I’m reminded of Schitt’s Creek when he says, I just write it off.

Tim:

Write it off. Or, the Seinfeld bit too. So just because you put it on the business credit card doesn’t make it a business expense. It’s still got to be something that you use for the business. It’s got to be ordinary and necessary expenses related to the operation or profit motive of your business. So yeah, you can put whatever you want on a business card that doesn’t make it deductible. So that’s where you get together with your accountant or your bookkeeper at the end of the year and say, here’s my bills. Which of these can I deduct? As a side note, one of the really important things we always remind a small business owners is have a separate business checking account, a separate business credit card to make it really easy to keep track of that, to have everything on one statement in one account for an accounting nightmare, we’ll drive up the fees of your tax prep and your accounting bookkeeping and all that.

So make your life simple. Get separate information for both. It is really worth the effort. There’s lots of expenses that will qualify that you can use as business expenses. Go back to that ordinary and necessary thing again, and the small test too a little bit. If it doesn’t seem quite right, maybe it’s probably not right. Use some common sense on things. And just because somebody said they did it on TikTok and they said, Hey, I did a deduction for this, that doesn’t mean it was a legitimate deduction. Just because I drove 50 miles an hour in a 35 mile an hour zone and didn’t get a ticket, doesn’t mean it’s okay. It just means I didn’t get caught.

Henah:

Correct.

Katie:

Amen. Katie,

Henah:

It looks like you had one last question.

Katie:

I do. Let’s talk about the best investment account potentially for self-employed people. They’re solopreneurs. Now, I know that to say the word best is a little aggressive, but I am personally very partial to the solo 401(k) since you can get that full $23,000 in 2024 or no in 2023. But I’m partial to the solo 401(k) because you can get that full employee elective deferral plus another 20% of net business income. I think it’s a really great option, but I know that the SEP IRA is an option too, and there are potentially things that I’m not even aware of. So how do you think about pre-tax investing for this group?

Tim:

I think both the vehicles you mentioned are pretty common. This is actually one of the more complicated areas of tax law. We call it the alphabet soup of retirement plan contributions, 401(k), 403B, 457s, IRA, simple IRA. And now they’ve come up with a couple of new ones as part of secure two. So there’s a lot of options out there, all with different levels, level of income. You can contribute maximum contributions if you have employees in your business. One plan may be more or less beneficial than another because if you have employees, you probably have to make contributions for them as well. So you got to make sure you’re okay with that. The two that you mentioned, individual 401(k), SEP IRA. Probably the two most common for most business owners who are looking to stock away as much as they can, and to your point, the individual 401(k) allows you to do more because it’s not necessarily a percentage of income.

It can be a dollar of income, whereas SEP requires it to be more of a percentage. So you’re correct individual 401(k) likely to be more commonly used in those cases for those who really want to guarantee maximizing their savings. If you are looking at income north of say, $350,000 or so, either plan’s going to provide you the same because then the percentage the SEP allows you to do will be the same as what you can put into the individual 401(k). So if you’re a high earner, then the two plans will allow you to do the same amount. Smaller levels of income. Individual 401(k) will allow you to do more. There’s some extra paperwork that goes with that. You can’t have employees. If you have an individual 401(k) with a SEP, you can. So there are other nuances there. But yeah, in general, people looking to save the most. The solo 401(k), the I 401(k), all the names that goes by, that’ll work.

Katie:

Amazing. Okay, well I think that’s it for this week’s episode of Rich Girl Roundtable and we will see you on Wednesday for our main episode. And Tim, thanks again so much for joining us. It was truly a delight.

Tim:

Thanks for having me.